OECD Economic Surveys: Euro Area

OECD’s periodic surveys of the Euro Area’s economy. Each edition surveys the major challenges faced by the country, evaluates the short-term outlook, and makes specific policy recommendations. Special chapters take a more detailed look at specific challenges. Extensive statistical information is included in charts and graphs.

OECD's 2012 Economic Survey of the Euro examines recent economic developments, policy and prospects. In addition it includes special chapters cover Euro Area imbalances and Euro Area governance and structural reforms and their short-term impact.

The euro area is experiencing a crisis related to sovereign debt in several countries. The crisis has its origins in the build-up of excessive financial, fiscal and economic imbalances in the euro area and the global credit cycle. The resolution of these imbalances has so far been incomplete, leading to a renewed bout of instability beginning in mid-2011. There is a risk that fiscal consolidation and potential bank deleveraging may restrict economic activity before the benefits of healthier public finances and reforms to boost growth materialise. High risk-spreads and self-fulfilling expectations could lead to unsustainable debt dynamics. There is a risk of global spillovers from these developments. This calls for both short-term action and long-term reforms.

The euro area is experiencing a crisis related to financial, fiscal and economic stress in several countries. Excessive imbalances built up during the upswing and during the crisis led to a renewed bout of financial instability starting in mid-2011 and a slump in demand. The weakening position of some private and government balance sheets undermined bank portfolios and confidence. Some euro area countries are experiencing a liquidity and confidence crisis. The close relationships between national governments and banking systems create strong feedback effects between fiscal sustainability and financial stability, aggravating the impact on financial conditions and reducing fiscal policy space. Output has weakened and growth is anticipated to remain below trend for some time as the result of the loss of confidence, tighter financial conditions and underlying retrenchment. There are large downside risks to the financial system and activity, depending on how the crisis is resolved. The capacity for additional monetary stimulus, fiscal support of demand and measures to support the banking system is much more limited than in 2008. Debt-to-GDP ratios are high in most euro area countries and market confidence in euro area sovereign debt is fragile. This limits the ability of fiscal policy to support activity and the financial system. At the same time, the effect of recent ECB measures is still unfolding and inflation expectations remain well-anchored.

The euro area sovereign debt crisis has its origins in the build-up of excessive economic, fiscal and financial imbalances in the euro area during the upswing of the credit cycle. Some euro area countries are experiencing severe financial and fiscal crises, as banking inflows have reversed and economic weakness has undermined the public finances. Resolving the underlying imbalances requires a range of policy responses across the euro area, notably structural reforms to bring savings and investment more closely into balance and a shift in relative prices across countries.In the near term, events have exposed the need for a funding mechanism to deal with sovereign liquidity crises within the currency union. The euro area authorities have responded with the creation of the European Financial Stability Fund (EFSF) and the future European Stability Mechanism (ESM). The ECB has played a key role in ensuring that the banking system across the euro area has had appropriate access to liquidity.The experience of the past decade underlined the need for a new cross-cutting approach to the governance of the euro area to avoid future imbalances and as the counterpart for the new crisis management arrangements. Economic, fiscal and financial governance and oversight have been strengthened significantly. However, implementation of the new framework will be key and further measures are needed in some areas, notably in creating a European system of financial crisis management and weakening the close link between banks and their domestic sovereigns.

Structural reforms are needed to restore sustainable and balanced growth in the euro area. Medium-term growth prospects in the absence of reform are weak and there are downside risks to future labour productivity growth. An ambitious programme of structural reforms could transform this outlook and raise medium-term growth substantially, improve the sustainability of public and private debt, and create jobs and boost incomes. Achieving these gains would require measures across a broad range of areas including product market regulations, labour market institutions, social benefits and tax systems.Some reforms would have positive effects on growth even in the short run, even though the full long-run benefits of reforms are likely to take time to materialise. There is a risk that some reforms could have a negative immediate impact, but this is often over-stated. Reform packages should be designed to achieve the best trade-off between short- and long-run effects, as well as take into account political economy considerations. Good communication and credible commitments, in addition to a well-functioning financial system, can boost the short-run growth benefits.Weaknesses in structural policy settings contributed to the build-up of euro area imbalances, for instance through restrictive product market regulations that held back investment or wage-setting institutions that allowed pay to get out of line with productivity or generated weak growth. Reforms would help to resolve and avoid imbalances by tackling their underlying causes. In surplus economies, structural reforms especially in the service sectors could facilitate investment and domestic activity. In countries with high levels debt and large imbalances, reforms should be focused on raising productivity to improve debt sustainability, avoiding structural unemployment, attracting foreign capital and facilitating wage and price adjustment to regain competitiveness. These reforms should create favourable conditions for the development of new activities, particularly in export-oriented sectors.